Treasury gain keeps key yield under 4.5%

Holiday-shortened week to feature Fed minutes, auction

By

RachelKoning

CHICAGO (MarketWatch) - Treasurys gained for a fourth day in five on Monday as bondholders grew more comfortable that yields offered enough compensation for inflation risk.

Longer-term maturity gains outpaced those for their shorter-term brethren, bringing the gap in yield between 2-year notes and 10-year notes to a nearly five-year low of 0.06 percentage point. Yields on 2-year debt and 3-year debt were the same for a second time this year. Longer-term debt typically rewards investors with higher yields for their longer exposure.

Economic reports last week offered relatively mild inflation readings and oil prices held below $60 a barrel to pacify fixed-income investors who lose purchasing power to inflation's impact. Add to that the Federal Reserve's oft-expressed resolve to stay a step ahead of inflation.

Oil futures closed at their lowest in five months Friday after fuel-supply increases reported last week eased forecasts for winter prices. See Futures Movers.

The CPI has now risen 4.3% in the past year, down from a 13-year high 4.7% pace. Core prices, those outside of volatile food and energy categories, are up 2.1% in the past year, but haven't shown much acceleration in the past few months. The Fed would like to keep core inflation below 2%.

Still basking in the latest inflation reading, the benchmark 10-year government note finished Friday with the first back-to-back weekly gain in some two months.

And on Monday, the 10-year finished up 9/32 at 100 10/32. That added more than $2.50 per each $1,000 in securities at face value.

The gain in price lowered the note's yield,
TNX, -1.21%
a reference for mortgage and corporate borrowing rates, to 4.46% from 4.5% at Friday's close.

Fed minutes awaited

The bond market continued to consolidate after a charge for benchmark yields earlier this month to near the year's high, 4.68% for the 10-year note set on March 23. Trading was relatively subdued to start a week shortened by the Thanksgiving holiday, one that's light on economic news. The bond market will close early on Wednesday and Friday, and is completely shuttered Thursday.

The Fed will release meeting minutes from its Nov. 1 policy meeting on Tuesday.

Interest rates were already in focus for the bond market on Monday, but on action outside of the United States.

Additional comments from European Central Bank President Jean-Claude Trichet tossed cold water on prospects for a series of rate increases in the euro-zone over coming months. Trichet's hints for the first move for rates since June 2003 stirred financial markets Friday.

On Monday, Trichet said that he didn't see "the start of a series of augmentation of interest rates."

"So, a rate hike in December ... and a pause?" pondered Mary Ann Hurley, vice president in fixed income with D.A. Davidson & Co. in Seattle.

Such prospects were seen keeping higher yielding U.S. bonds a lure for foreign money over euro-zone bonds.

Treasurys retained price increases even as stocks gained following General Motors' announcement of a job-cutting restructuring that some analysts said was necessary to avoid a filing under the bankruptcy laws. Jobs cuts were expanded to 30,000, a number that could impact national statistics, said Hurley.

Bonds and stocks often move inversely and Treasurys had gained earlier this month in a move said to reflect "flight-to-safety" demand to seek cover from the impact GM could have on financial markets and the economy. See Market Snapshot.

Bets are on slower growth

The gap between the 2-year and 10-year Treasury yield was 0.06 percentage point. It was at its tightest in nearly five years. Known as the yield curve, this indicator is often consulted for its predicting powers for future economic growth, inflation and interest rates.

A flat yield curve, the graph that plots the range of returns from shortest to longest maturity, can sometimes reflect bets that economic growth will slow; inverted curves have sometimes preceded economic recession.

The gap stood at more than 1.8 percentage points when the Fed began to tighten interest-rate policy beginning in June 2004, before short-term yields started to rise in sympathy with the Fed's moves.

The curve had steepened early this month when a series of inflation reports and mixed expectations for the effectiveness of Fed policy took 10-year yields to near the year's high.

A Ried Thunberg ICAP survey of money managers from late last week showed a slightly more optimistic outlook for bonds.

The index reflecting the near-term outlook rose to 48 from 46 the week before. That means those surveyed look for 10-year note prices to gain by June. The longer-term index slipped slightly, to 50 vs. 51, but remained above the key 50 threshold for a fourth week.

Despite last week's optimism, Ried Thunberg analysts continue to expect the Fed to boost its target lending rate well into next year, which may slow economic growth to the benefit of bond investments.

Monday's sole economic release, the index of leading economic indicators, rose a larger-than-expected 0.9% last month, according to the private sector research firm Conference Board. October's marked the first increase in the past four months. See Economic Calendar.

Despite the October rebound, the leading index has been fluctuating around a relatively flat trend this year.

"Although it is still difficult to distinguish between the impact of the hurricanes and overall economic conditions, the recent behavior of the leading index is still consistent with the economy continuing to expand more moderately in the near term," the Conference Board said. See Economic Report.

Short-term price gains could be held in check this week as the government prepares to sell $20 billion worth of new 2-year notes on Wednesday. Competing debt tends to depress prices and lift yields on notes already in circulation.

The auction size was in line with market expectations, although some observers thought a $22 billion offering might be announced.

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